Can't Blame Trump for Everything

So much has happened since the Presidential election - and almost none of it very obvious.

The plunge in equities on Donald Trump's victory was foreseeable. The bounce was also foreseeable. The fact that the bounce completely reversed the selloff and took the market to within a whisker of new all-time highs was not, in my mind, an easy prediction. I understand that Mr. Trump intends to lower corporate tax rates (and he should, since it is human beings - owners, customers, and employees - that end up paying those taxes; taxing a company is just a way to hide the fact that more taxes are being layered on those human beings). And I understand that lowering the corporate tax rate, if it happens, is generally positive for corporate entities and the people who own them. I'm even willing to concede that, since Mr. Trump is - no matter what his faults - certainly more capitalism-friendly than his opponent, his election might be generally positive for equity values.

But the problem is that equities are already, to put it generously, "fully valued" for very good outcomes with Shiller multiples that are near the highest ever recorded.

I think that investors tend to misunderstand the role that valuation plays when investing in public equities. Consider what has happened to the economy over the last eight years under President Obama: if you had known in 2008 that growth would be anemic, debt would balloon, government regulation would increase dramatically, taxes would increase, and a new universal medical entitlement would be lashed to the backs of the American taxpayer/consumer/investor, would you have invested heavily in equities? Yet all stocks did was triple. The reason they did so was that they started from fairly low multiples and went to extremely high multiples. This was not unrelated to the fact that the Fed took trillions of dollars of safe securities out of the market, forcing investors (through the "Portfolio Balance Channel") into risky securities. By analogy, might stocks decline over the next four years even if the business climate is more agreeable? You betcha - and, starting from these levels, that's not terribly unlikely.

I am less surprised with the selloff in global bond markets, and not really surprised much at all with the rally in inflation breakevens. As I've said for a long time, fixed-income is so horribly mispriced that you should only hold bonds if you must hold bonds, and then you should only hold TIPS given how cheap they were. Because of their sharp outperformance, 10-year TIPS are now only about 40-50bps cheap compared to nominal bonds (as opposed to 110 or so earlier this year), and so it's a much closer call. They are not relatively as cheap as they were, but they are absolutely less expensive as real rates have risen. 10-year real rates at 0.37% aren't anything to write home about, but that is the highest yield since March.

Some analysis I have seen attributes the large increase in market-based measures of inflation expectations on Mr. Trump's victory. For example, 10-year breakevens have risen 20bps, from about 1.70% to about 1.90%, since Mr. Trump sealed the win (see chart, source Bloomberg).

I think we have to be careful about blaming/crediting Mr. Trump for everything. While breakevens rose in the aftermath of the election, you can see that they were rising steadily before the election as well, when everyone thought Hillary Clinton was a sure thing. Moreover, breakevens didn't just rise in the US, but globally. That's a very strange reaction if it is simply due to the victory of one political party in the US over another. It is not unreasonable to think that some rise in global inflation might happen, if Trump is bad for global trade...but that's a pretty big reach, and something that wouldn't happen for some time in any event.

In my view, the rise in global inflation markets is easy to explain without resorting to Trump. As the previous chart illustrates, it has been happening for a while already. And it has been happening because global inflation itself is rising (although a lot of that at the moment is optics, since the prior collapse of energy prices is starting to fall out of the year-over-year figures).

The bond market and the inflation market are acting, actually, like the Great Unwind was kicked off by the election of Donald Trump. We all know what the Great Unwind is, right? It's when the imbalances created and nurtured by global central banks and fiscal authorities over the last couple of decades - but especially in the last eight years - are unwound and conditions return to normal. But if pushing those imbalances had a soothing, narcotic effect on markets, we all suspect that removing them will be the opposite. Higher rates and inflation and more volatility are the obvious outcomes.

Equity investors don't seem to fear the Great Unwind, even though stock multiples are one of the clearest beneficiaries of government largesse over the last eight years. As mentioned above, I can see the argument for better business conditions, even though margins are still very wide. But I'm skeptical that better business conditions can overcome the headwinds posed by higher rates and inflation. Still, that's what equity investors are believing at the moment.

A couple of administrative announcements about upcoming (free!) webinars:

On Thursday, November 17th (aka CPI Day), I will be doing a live webinar at 9:00ET talking about the CPI report and putting it in context. You can register for that webinar, and the ensuing Q&A session, here. After the presentation, a recording will be available on TalkMarkets.

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